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Volume-Based Costing Versus ABC Pioneer Pharmaceutical Company produces three drugs: Varnacin, Kresacin, and Hannacyn belonging to the anti-viral family of medication. Since its inception four
Volume-Based Costing Versus ABC | |||||
Pioneer Pharmaceutical Company produces three drugs: Varnacin, Kresacin, and Hannacyn belonging to the anti-viral family of medication. Since its inception four years ago, Pioneer has used a direct labor-hour-based system to assign manufacturing overhead costs to products. | |||||
Hugh Elliott, the president of Pioneer, has just read about activity-based costing in a trade journal. With some curiosity and interest, he asked his financial controller, Matilda Dodge, to form an interdisciplinary committee to examine differences in product costs between the firm's current costing methods and activity-based costing systems. Pioneer has the following budget information for the year: | |||||
Varnacin | Kresacin | Hannacyn | |||
Cost of direct materials | $164,000 | $212,000 | $206,400 | ||
Cost of direct labor | $200,000 | $187,200 | $210,400 | ||
Number of direct labor-hours | 5,760 | 5,440 | 1,600 | ||
Number of capsules | 800,000 | 400,000 | 240,000 | ||
The ABC committee has identified the following activities as cost drivers and has allocated them to total overhead cost of $163,900 as follows: | |||||
Budgeted Overhead Cost | Budgeted Cost Driver Volume | ||||
Activity | Cost Driver | ||||
Machine setup | Setup hours | $13,100 | 1,300 | ||
Plant management | Workers | 29,500 | 1,000 | ||
Supervision of direct labor | Direct labor-hours | 37,700 | 900 | ||
Quality inspection | Inspection-hours | 41,300 | 800 | ||
Expediting orders | Customers served | 42,300 | 500 | ||
TOTAL OVERHEAD | $163,900 | ||||
The ABC committee selected the cost drivers with the following justifications: | |||||
SETUP HOURS: The cost driver of setup hours is used because the same product takes about the same amount of setup time regardless of size of batch. For different products, however, the setup time varies. | |||||
NUMBER OF WORKERS: Plant management includes plant maintenance and corresponding managerial duties that make production possible. This activity depends on the number of workers. The more workers involved, the higher the cost. | |||||
SUPERVISION OF DIRECT LABOR: Supervisors spend their time supervising production. The amount of time they spend on each product is proportional to the direct labor-hours worked. | |||||
QUALITY INSPECTION: Inspection involves testing a number of units in a batch. The time varies for different products but is the same for all similar products. | |||||
NUMBER OF CUSTOMERS SERVED: The need to expedite production increases as the number of customers served by the company increases. Thus, the number of customers served by Pioneer is a good measure of expediting production orders. | |||||
The ABC committee gathered the following information about the cost-driver volume for each product: | |||||
Varnacin | Kresacin | Hannacyn | |||
Machine setups | 160 | 490 | 650 | ||
Plant management | 160 | 330 | 510 | ||
Supervision of direct labor | 160 | 250 | 490 | ||
Quality Inspection | 120 | 160 | 520 | ||
Expediting production orders | 40 | 80 | 380 | ||
Required: | |||||
a. Use the firms current costing system to calculate the absorption unit cost of each product. Round your answer to four places to the right of the decimal point. | |||||
b. Use the activity-based costing system to calculate the unit cost of each product. Round your answer to four places to the right of the decimal point. | |||||
c. The two costing systems provide different results; give reasons for this. Why might these differences be strategically important to Pioneer? How could ABC add to Pioneers competitive advantage? Write your answers in the spaces provided on the (c) answer worksheet. |
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